Why Africa's Approach to Financial Risk Management Needs to Change

For nations grappling with rising levels of sovereign debt, unpredictable regulatory uncertainties, and the far-reaching repercussions of political transitions, traditional frameworks, often borrowed from more stable economies, fail to account for the volatility and complexity inherent in many African markets – necessitating a re-evaluation of how financial risks are quantified and managed on the continent.

Recent developments in several countries have been particularly illustrative of this.

In Ghana, faced with substantial revenue collection pressures due to an economic downturn, the Ministry of Finance took an unprecedented decision to defer both coupon and principal payments on local currency bonds. In Nigeria, a sudden regulatory shift by the Central Bank, which banned the use of futures for hedging against Naira fluctuations, left many financial practitioners with significant unhedged liabilities overnight as the currency depreciated. Meanwhile, in Kenya, proposed stringent tax measures sparked widespread protests, exacerbating economic instability in the region’s economic linchpin.

All this unfolds as several countries on the continent and internationally, head to the polls in 2024, where the formation of new governments often leads to a temporary paralysis in decision-making. In the absence of established authorities to authorise contracts, service payments, and facilitate public-private partnerships, regulatory and economic processes are significantly stalled.

The combination of regulatory headwinds and the vacuum created by government transitions often triggers a downward spiral in economic activity, creating a self-reinforcing cycle of stagnation. In these periods, policy frameworks and market activity tend to shift erratically, making it increasingly difficult to navigate the financial landscape with confidence.

The difficulty then lies not only in understanding the changes, but in predicting and adapting to them in a manner that remains politically and economically viable – a challenge where African financial institutions have a critical role to play. This is expected to be at the forefront of discussions at the Absa Macro and Risk Management Conference, where industry experts will unpack the strategies needed to navigate this complex environment.

The financial services sector has transformed into vast repositories of data, capturing details of market movements, client portfolios, and financial transactions on a global scale. But collection is obsolete without effective consolidation and utilisation: the true potential of these data capabilities lies in moving beyond generic risk metrics, enabling the development of more precise and adaptive financial strategies. By tailoring risk assessments and investment decisions to the specific behaviours and exposures of their clients, financial institutions can better navigate the complexities of volatile markets and shifting regulatory landscapes.

To achieve this, we must first rethink our approach to quantifying risk – an area that has often overestimated potential risks in African markets. This requires integrating additional variables into the modelling process. For example, incorporating historical realised losses given a sovereign default, or alternatively, the actual recovery rates post-defaults, can significantly alter the outlook. Furthermore, integrating environmental scenarios – with climate change, natural disasters, and resource scarcity all having profound effects on economic stability and asset values – allows financial institutions to better anticipate potential financial risks and adapt their strategies accordingly.

Diversification and liquidity management strategies also need to be considered differently, with a focus on carefully balancing risk across countries, regions, sectors, asset classes and counterparties. By intentionally spreading exposure, the sector can mitigate the impact of localised shocks and stabilise returns, even in volatile markets. Additionally, maintaining a strategic liquidity buffer ensures that financial institutions can swiftly respond to market disruptions or capitalise on emerging opportunities when others may be forced to retreat.

At the heart of these strategies is a powerful enabler: technology.

Artificial Intelligence (AI) and machine learning (ML) are revolutionising financial risk management by enabling the rapid analysis of vast data sets, uncovering patterns and trends beyond the reach of traditional methods, and delivering a more nuanced understanding of market dynamics and client behaviours.

Banks like Absa are increasingly adopting such technologies to enable real-time analysis of market data, allowing for the early identification of emerging risks and opportunities. Aside from predictive analytics, Absa is also using AI to enhance client engagement. Bankers can access these platforms to receive curated insights on critical market developments likely to impact clients, facilitating more proactive discussions and strategic decision-making.

These technological strides underscore the broader shift required in financial risk management – where real-time intelligence will become the cornerstone of a resilient financial strategy.

Reinventing financial risk management is therefore a strategic necessity. As Africa's economic landscapes evolve, only those frameworks that are adaptable, data-driven, and attuned to local realities will prove effective.